Innovative Industrial Properties Inc (IIPR) 2017 Q4 法說會逐字稿

Good day, everyone, and welcome to the Innovative Industrial Properties, Inc. Fourth Quarter 2017 Earnings Conference Call. (Operator Instructions) Please also note that today's event is being recorded.

At this time, I'd like to turn the conference call over to Mr. Brian Wolfe, General Counsel. Sir, please go head.

Thank you for joining the call. Presenting today are Alan Gold, Executive Chairman; Paul Smithers, President and Chief Executive Officer; and Catherine Hastings, Chief Financial Officer.

Before we begin, I'd like to remind everyone that statements made during today's conference call may be deemed forward-looking statements within the meaning of the safe harbor of the Private Securities Litigation Reform Act of 1995, and actual results may differ materially due to a variety of risks, uncertainties and other factors.

For a detailed discussion of some of the ongoing risks and uncertainties of the company's business, I refer you to the news release issued yesterday and filed with the SEC on Form 8-K as well as the company's reports filed periodically with the SEC.

The company disclaims any intention or obligation to update or revise any forward-looking statements whether as a result of new information, future events or otherwise.

Before I hand the call over to Alan, I want to mention that we have limited time for the call today, but we will answer as many questions as we can after our prepared remarks. Alan?

Thank you, Brian, and welcome, everyone. Today, we get a chance to review and share our financial results for the fourth quarter and full year 2017, and provide our updated perspective on the business and the industry from our last call in August. Overall, we are pleased with the execution on our business plan during our first full year of operation since going public and beginning real estate operations in December 2016, having acquired 4 additional properties and committed substantially all of the capital we raised from our IPO, and our subsequent Series A preferred stock offering in October of 2017.

At year-end, we own 5 properties in 4 states, totaling approximately 617,000 square feet, which were 100% leased on a long-term basis to high-quality, licensed, medical-use cannabis operators. Our initial blended yield on these properties is 15.8%, with each lease providing minimum annual escalations ranging from 3.25% to 4% with a weighted average remaining lease term of nearly 15 years as of year-end.

Our fourth quarter was very active in terms of acquisitions. In December, we closed on a sale-leaseback transaction for a 358,000 square foot medical-use cannabis cultivation and processing facility with The Pharm in Arizona, and closed on 2 other sale-leaseback transactions with Vireo in the states of New York and Minnesota in October and November. Paul will provide more details regarding these transactions and the new additions to our tenant roster.

And we also declared our third consecutive quarterly common stock dividend of $0.25 per share to stockholders of record as of December 29, 2017, representing a 67% increase over our third quarter 2017 dividend of $0.15 per share, after having generated $0.67 per diluted share in adjusted funds from operations for the year, truly a remarkable achievement for such a young company. Now Catherine will provide more detail regarding our financial results.

As we discussed in our last call, the medical-use cannabis industry is constantly evolving, including the strong growth of existing state markets and the rollout of new programs passed in numerous states by popular vote or legislation in recent years. Paul will provide further perspective on these changes and other industry trends in our call today, in addition to discussing in further detail our properties, individual state markets, tenants and pipeline. Now this is still a nascent industry that is witnessing amazing growth with state-regulated medical-use cannabis markets now comprising a large majority of the United States. We are very optimistic about the future of this industry and our ability to deliver results for our stakeholders and enduring value to our tenant partners by providing tailored real estate solutions that meet key operational and capital needs.

With that, I'd like to turn the call over to Paul. Paul?

Thanks, Alan. As Alan alluded to, this is a rapidly evolving industry and we'll try to provide as effective an overview as we can with the short time we have today, focusing in on 4 main topics. One, the current regulatory environment; two, the growth and evolution of the medical-use cannabis market in the United States, generally; three, an update on the New York, Arizona, Maryland and Minnesota markets and our tenants; and finally, our pipeline.

First, regarding the current regulatory environment. As you all know, there continues to be much discussion about a reevaluation of the federal government's enforcement posture as it relates to the cannabis industry. To summarize the current status, cannabis remains a Schedule 1 controlled substance, which generally prohibits all cannabis use and cannabis-related commercial activity in the United States. That said, Congress has enacted spending bills since 2014 with a provision that has been interpreted by courts as preventing the Department of Justice from using funds to interfere with the implementation of state medical-use cannabis laws. That provision was again included in the Congressional spending bill enacted on March 23, which carries through to September 30 of this year.

While we are pleased to see that Congress has continued to move in a direction that clearly represents the will of the people as it serves, we continue to monitor federal government positions closely and are cautiously optimistic that the executive branch of the federal government will do the same. In addition, there are numerous other initiatives taken by Congress, including the establishment of the bipartisan Congressional Cannabis Caucus in 2017, and the introduction of a number of bills in Congress in favor of various forms of cannabis legalization at the federal level.

Onto a general update of the medical-use cannabis markets nationwide, the industry continues to move forward with tremendous velocity. States that have legalized medical-use cannabis by popular vote or legislative process now comprise a majority of the U.S. with over 200 million residents, including an estimated 2.5 million people having used or been registered to use legalized medical cannabis. Medical-use cannabis continues to poll with 90%-plus popular support in the United States, and the cannabis industry is expected to continue to be a leading driver for U.S. jobs and tax revenues. In fact, New Frontier Data projects that the state legal cannabis industry could create over 280,000 jobs and generate $2.3 billion in cannabis-specific state taxes by 2020 in states which have already legalized medical or adult-use cannabis.

Drilling down a bit on current markets in New York, Arizona, Maryland and Minnesota, where our 5 properties are located, we see tremendous potential in each. As you may recall, we purchased our first New York property in December 2016 in a sale-leaseback transaction with PharmaCann for a 15-year initial term and an all-in initial yield of about 17% on a triple-net basis. PharmaCann is a multistate operator with 2 cultivation facilities and 4 medical-use cannabis dispensaries in Illinois, and our cultivation facility and 4 medical-use cannabis dispensaries in New York. PharmaCann has also been awarded licenses in Massachusetts, Maryland and Pennsylvania. Our New York property is about 127,000 square feet and construction of the facility was completed in mid-2016.

We acquired our second New York property in October of 2017 in a sale-leaseback transaction with Vireo Health for a 15-year initial term at an annual base rent equal to 15% of the sum of the purchase price and available tenant improvement allowances, with a 1.5% property management fee and annual base rental increases of 3.5% for the term. Vireo Health is also a multistate operator, conducting cultivation, processing and dispensing operations in New York and Minnesota as well as cultivation and processing operations in Pennsylvania.

As discussed on our last call, the New York medical-use cannabis program as initially rolled out has been described by many as one of the most restrictive and highly regulated. In response and in order to enable broader access to treatment, New York has taken several positive steps, including expansion of the pool of potential recommending health professionals to include nurse practitioners and physician assistants, allowing for home delivery of the medicine, the streamlining of the registration process for practitioners and certification process for patients, and perhaps most importantly, the introduction of chronic pain and PTSD as additional qualifying conditions.

ArcView Market Research, in consideration of the changes made in the program, the market potential and the estimated overall size of the illicit market in New York of nearly $3 billion, has estimated $254 million in sales in New York's legal market by 2021, representing a compounded annual growth rate from 2016 of 48%. We see encouraging signs of that accelerating growth and the early stages of the impact of the regulatory changes in New York's available state level data. Patient count has more than doubled since the addition of chronic pain as a qualifying medical condition a year ago, with over 48,000 patients registered as of March 27 of this year.

Now onto our Arizona property. In December 2017, we entered into a sale-leaseback transaction with The Pharm for a 358,000 square foot industrial and greenhouse facility in Arizona. The lease has a 15-year initial term at an annual base rent equal to 14% of the sum of the purchase price and available tenant improvement allowance, subject to an initial partial rent abatement that expires this month. There's also 1.5% of property management fee and annual base rental increases of 3.25% for the term. The Pharm is one of the largest wholesalers of medical-use cannabis in the Arizona market, with a highly experienced multidisciplinary management team that is well positioned to grow The Pharm's market share in Arizona and facilitate expansion into other states.

Arizona's medical-use cannabis program is further along in its maturity than New York, having commenced medical-use cannabis sales in 2010. According to the Arizona Department of Health Services, there are over a 150,000 qualifying patients in Arizona's medical cannabis program as of February 2018, representing an increase of over 30% year-over-year, with over 85% of registered patients utilizing medical cannabis to treat chronic pain. ArcView expects that growth to continue, projecting a nearly 30% compound annual growth rate in total legal cannabis spending from 2016 to 2021 in Arizona.

Now onto Maryland. In May of 2017, we purchased 9220 Alaking Court in Capitol Heights, a well located property under development at the time of our acquisition. Development was completed in August and the property comprises approximately 72,000 square feet. At the close of the acquisition, we entered into a pure triple-net lease with Holistic Industries, one of only a handful of operators in the state of Maryland to have received final licenses for complete vertical integration, meaning cultivation, processing and dispensing of medical-use cannabis.

Our initial yield on our aggregate investment of $16.9 million, excluding closing cost, is 15.4% with a 3.25% fixed rental escalations on $15 million of our investment, over a 16-year total initial lease term. The Holistic team brings with it significant years of experience working in the industry, including as regulated medical-use cannabis operators in Washington D.C. Holistic secured financing commitments of $9 million in 2017 to support commencement of its operations in Maryland. Although still in its very early stages, with the first dispensary is open in late 2017, we are optimistic regarding the development of the legal medical-use cannabis market in Maryland, driven by Maryland's population size and anticipated demand, the inclusion of PTSD and chronic pain among the initial qualifying conditions and the general view from regulators and policy makers that the industry represents an economic development opportunity.

Lastly, onto Minnesota. We acquired our Minnesota property in November of 2017 in a sale-leaseback transaction with Vireo Health, for a 15-year initial term at an annual base rent equal to 15% of the sum of the purchase price and available tenant improvement allowance. The lease includes a 1.5% property management fee and annual base rental increases of 3.5% for the term. Vireo is 1 of 2 licensed medical cannabis operators in the state of Minnesota, while smaller market that began medical cannabis and sales in mid-2015, the medical cannabis program in Minnesota has experienced significant and accelerating growth, increasing patient count by over 100% year-over-year to over 8,000 actively enrolled patients as of year-end 2017. Growth in health care practitioners has experienced a similar trajectory with over 1,000 health care practitioners now approved in the registry system. Similar to New York, Minnesota's medical cannabis program was initially rolled out as a highly regulated and restricted program but has gradually expanded the program for treatment of additional medical conditions, including intractable pain and PTSD, and most recently, autism, spectrum disorders and sleep apnea.

Now onto our acquisition pipeline. We are intensely focused on investing the proceeds from our recent completed follow-on common stock offering in the best opportunities, high quality assets, top tier tenants with strong balance sheets and management teams in the states where we have confidence in the regulatory environment. In the first quarter, we executed agreements to purchase 2 properties for a total investment of $10.5 million. In addition, we executed 2 nonbinding letters of intent for 2 properties representing a total expected additional investment of approximately $25 million to $30 million, with final amounts to be determined after we complete our review and improve the level of future tenant improvements at each property. We are also actively evaluating a pipeline of approximately $100 million in additional acquisitions, spanning numerous states that have approved medical-use cannabis programs. We're also closely monitoring developments in California and are engaged in numerous discussions with high quality cultivators there. As with any emerging, dynamic, high growth industry, we are adapting our acquisition strategy and criteria accordingly. We are seeing excellent opportunities and our pipeline includes both near-term opportunities and longer-dated investment opportunities.

I'll now turn the call over to Catherine, who will walk you through our financial results for the fourth quarter and full year 2017. Catherine?

Thanks, Paul. Having completed our IPO in December 2016 and having begun real estate operations shortly thereafter with our initial property acquisition in New York, 2017 represents just our first full year of operations. We had total revenues of $2.3 million in the fourth quarter of 2017 and $6.4 million for 2017.

As we noted, rent for our property in Arizona, which we acquired in December, is subject to an initial partial rent abatement that ends this month, and we acquired both of the Vireo Health properties in the fourth quarter. So we recognized only a partial quarter of rent from these 3 properties. We recognized rental revenue for all of our leases on a cash basis.

For the 3 months ended December 31, 2017, we recorded net income of $284,000. Funds from operations, which adds back property depreciation to net loss was $646,000 and adjusted funds from operations, which adds back noncash stock-based compensation was $817,000. For the full year 2017, we recorded a net loss of $395,000, funds from operations of $520,000 and adjusted funds from operations of $2.4 million.

As Alan mentioned, on January 16, we paid our third consecutive quarterly dividend of $0.25 per share to common stockholders of record as of December 29, which represents a 67% increase over the third quarter common stock dividend of $0.15 per share. And 2 weeks ago, we declared our Q1 2018 dividend of $0.25 per common share, which is payable on April 16, to shareholders of record as of today.

On the capital raising side, in October, we raised an additional $14 million in net proceeds through the issuance of 600,000 shares of Series A preferred stock in an underwritten public offering. We then completed an underwritten follow-on public offering of common stock in January, raising $79.3 million in net proceeds through the issuance of 3,220,000 shares of common stock, which includes the exercise in full of the over-allotment option granted to the underwriters.

Finally, I would like to note that our financial results were achieved utilizing a very conservative overall capital structure, funded entirely with preferred and common equity and no debt.

With that, I'll turn it back to Alan. Alan?

Thanks, Catherine. It has been a very eventful first year as a public company and we are excited about the opportunities to come. I want to thank the stockholders for your continued support, and we look forward to continuing to execute on our exciting business model by servicing this very promising industry as a long-term real estate and capital provider, and to creating sustainable long-term value for our stockholders.

And with that, I'd like to open it up for questions. Operator, could you please open the call up for questions.

(Operator Instructions) And our first question today comes from John Massocca from Ladenburg Thalmann.

To the extent you can provide it, can you give some -- us some color on the $10.5 million of properties under acquisition agreement and the properties under LOI? What are the ballpark kind of numbers for cap rate, lease term, rent bumps, et cetera?

Sure, I mean, I think the -- we're very pleased that we're able to maintain our yield requirements on these transactions ranging in the mid-teen numbers. And with the same sort of lease term and lease structure that Paul described up on the acquisitions we acquired in 2017, we continue to see a very strong pipeline of similar type transactions with the same mid-teen type yields with -- and people understanding our investment criteria in structures.

Understood. And then, kind of, in that same vein, have you seen pricing maybe for alternative sources of capital for potential tenants, kind of, i.e. private loans et cetera? Has that moves -- rates for that kind of capital moved up given your appeal of the Cole Memo, has there been a reduced availability of capital for some of your potential tenants?

I mean, I -- well, one, we're not in that market looking for that type of product ourselves. I mean, we are talking to many of our growers and we are seeing an increased size of our pipeline, which leads us to believe that there is either a more constrained capital in the market in general. And anecdotally, we are hearing of that very same thing. I think that also, that given the success of Innovative Industrial Properties and the fact that we continue to have access to capital that growers are now looking to us as a primary source of growth capital. And so we're benefiting from, I think, those 2 situations.

Understood. And then, are there any new markets maybe that are coming into focus particularly as certain states, 2 that come to mind, Florida, Pennsylvania are getting farther along in putting together the regulatory framework for their medical cannabis programs?

Sure. John, this is Paul. Yes, so there's definitely 5 or 6 states we're looking at that are in the rollout part of the program. You mentioned Pennsylvania, Massachusetts, we're looking at Michigan and Florida, Ohio, California. But it was also kind of fun to notice is there is 5 states that we'll probably have on this November ballot of medical cannabis programs. So this time next year, we'll probably be looking at these states, and probably it's going to be Oklahoma, Kentucky, South Dakota, Utah and Missouri have a real good chance of having medical programs on the ballot this year. So it's looking very positive for the market growth.

Run out of places where it's not legal?

Exactly.

Yes, exactly. And then kind of -- within maybe markets that already are kind of mature from a -- or already have a medical cannabis program, have you seen a move to maybe relax the program? I know you've talked about New York becoming less restrictive, Minnesota has historically become less restrictive, New Jersey just recently announced it's becoming less restrictive. It's opening up the program to more conditions and making it easier for patients to get into the program. Is that a trend you are seeing kind of beyond maybe the markets I mentioned?

Yes, absolutely. So with the 90%-plus national approval of medical cannabis are really seeing at the state level. And the programs that you mentioned in some of the other states as well, the states we like and are interested in being in business in are those states, where they have a Department of Health or a regulatory scheme that really works with the individual market. So they are hands on, they get an idea, if the patient count is not where it needs to be, they'll add additional medical conditions, they'll add maybe home delivery, maybe they'll add different delivery methods like flower or edibles or topical. So yes, we're looking at -- all the states are really working with their programs and adjusting as needed to ensure the patient count. So that's definitely the trend. It's definitely getting more forward looking.

Yes. And just to add to Paul's comment there, I think the primary reason for the states regulatory environments working with the growers is not only to benefit the patients but also to increase tax revenues that these states desperately need.

(Operator Instructions) And ladies and gentlemen, at this time, I'm showing no additional questions. I'd like to turn the conference call back over for any closing remarks.

Well, thank you, and once again, I'd like to thank you all for joining us today on this call, and we look forward to greater success as we move forward. With that, operator, the call is over. Thank you.

Ladies and gentlemen, that does conclude today's conference call. We do thank you for attending today's presentation. You may now disconnect your lines.